Cash vs. Accrual Accounting For Non-Profits:
Which is Right for Your Organization?
While many commentators are suggesting that nonprofits need to adopt accrual accounting, not
every Executive Director or Board Member understands the debate, or even the difference
between cash accounting and accrual accounting. While it’s widely agreed that accrual better
reflects the financial health of your organization, people still resist it thinking that it is too
complex for nonprofits.
We think this is a misconception of nonprofits and sells them short. There are many very
talented people in the nonprofit arena, and this becomes truer all the time. In fact, the recent
recession drove many talented business people to seek nonprofit positions, while nonprofits
have been recruiting from the business world for years. There is no denying that accrual takes
more sophistication, and even some well established business owners struggle with it, but if it is
a more accurate method and results in better financial health, then nonprofits owe it to their
donors to make the effort.
This month, Cathedral provides an overview of the advantages of switching your organization to
the accrual method, and why it makes sense for your organization.
Technical Aspect of Cash vs. Accrual Accounting
There are two general methods of accounting that nonprofit organizations have to choose from;
cash method or accrual method. For some smaller organizations, it makes sense to use the
cash method of accounting because it mirrors “check book accounting”. This is the same as
when you balance your check book, using debits and credits as the transactions occur. This
method is the simplest way of showing inflows of cash coming into the organization and
outflows of cash moving out.
The cash method is the widely accepted standard for non-profits and many people never even
consider the accrual method. The fact that the cash method mirrors what you do with your
checkbook every month makes it comfortable for non-profit executives with little accounting
experience. In addition, when cash is tight, cash method accounting is the easiest way to
manage bank balances.
A basic example of the cash method is that, for example, if your organization receives a
$100,000 pledge today, the cash method suggests you do not record this $100,000 until the
cash is in the bank. There are certainly exceptions to this example and many readers have no
doubt seen variations on the above, but the numerous exceptions and variations is part of the
problem with cash basis accounting, as we will point out below. In the next section, we’ll explain
how this would be recorded using the accrual method.
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The accrual method of accounting differs from the cash method in that it focuses on recording
revenue and expenses when the transaction takes place, regardless of when the cash actually
moves in and out of the organization. Using the same example from the previous paragraph,
the accrual method illustrates that the organization would record this pledge revenue
immediately and then creates a receivables account for the outstanding cash. Expenses are
recorded in a similar approach. As a bill is received, it would be recorded when it comes in the
door. The payment is then recognized as a payable until an actual payment is made.
Below is an illustration of this example. Using the $100,000 in pledges, the example below
assumes only $10,000 will be received in cash at the end of the first period using the cash
method, but $100,000 is recognized under the accrual method during the same period. The
expenses indicate that under the cash method, $20,000 in checks were written out, however,
under the accrual method, this example indicates that $60,000 in bills were received, creating
$60,000 in accounts payable under the accrual method.
It is important to remember that transactions may occur in one period under the accrual method
that do not occur in the same period with the cash method. This example below is a basic view
of how different an organization’s end of period financials can look when comparing cash vs.
accrual. Click here for Cathedral’s paper on better understanding nonprofit financial statements.
End of Period 1 Statement of Earnings
Cash Basis
Accrual Basis
$ Contribution Received $10,000
$ Invoiced to Donor
$100,000
$ Paid out for expenses $(20,000) $ Entered As Bills for Expenses $(60,000)
Net Earnings
$(10,000) Net Earnings
$40,000
The main goal of the accrual method is to recognize the financials in the correct time period in
which events occur, depending on when the information is reported. The illustration above
shows these events occurring during different periods. The accrual method records revenues
and expenses when the events actually take place providing a complete financial picture for the
entire year, something that some organization’s boards and management may have not seen
before. This presents a greater tool for these leaders and budgeting of the organization.
The cash method can confuse the financial picture depending on how your organization cash
flows. If the organization relies primarily on one month a year for cash flow – as is often the
case with end of the year giving, the cash method may not accurately portray when that revenue
is taking place, but only when it comes in the door, creating a lopsided picture of the
organization’s revenue. Perhaps your organization only receives a few grants a year and the
checks come in the mail on the same day. From a budgeting standpoint under the cash
method, the financials would only show revenues for one month during the year. On the other
hand, using the accrual method, if the pledges were received in January, February, and March
that would allow the organization to record the revenue in those months, better reflecting the
rhythm of the organization’s fundraising. Accrual gives a better picture of when grants and
pledges are “won” regardless of when they are paid. This is a basic example, but important
example for understanding how to more accurately record your financials.
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Variations of Cash Accounting
Cash basis accounting sounds so easy, and it would be, if indeed every transaction could be
recorded only when the money changes hands, but of course, our economy does not work that
way. Bills are pre-paid, pledges are made, grants are deferred, funds are held in special
reserve accounts, etc. What happens to cash accounting when one of these events occurs?
Accrual starts to creep in. Most accountants would agree true 100% cash accounting does not
really exist. Nearly all cash basis accounting has some element of accrual in it. This
phenomenon has come to be called “modified cash accounting.” Perhaps the biggest problem
with modified cash accounting is that no two “modifications” are the same. There is no uniform
way to run a modified cash accounting system. For this reason, GAAP does not recognize
cash, or modified cash accounting1. GAAP usually assumes that all activities within an
organization are recorded under the same accounting method.
In fact, most nonprofit organizations that file tax returns (Form 990) usually file accrual based
returns. This is due to recent changes to the new form 9902. Schedule A of the form 990
requires adjustment for accruals. If a nonprofit organization is receiving an audit and wish to
receive an “unqualified opinion”, the organization would be required to use the accrual method.
Should a Nonprofit Organization Switch?
As your organization grows, a more comprehensive accounting method is appropriate, not only
from the aspect of auditors, but for your board and management. The size of your organization
does not always indicate which accounting method to use, but it is more likely that with budgets
over $500,000, the cash method begins to get more problematic as the need for accrual rises
and “modified cash basis accounting” begins to set in.
It is often stated that smaller organizations without the resources or means to use the accrual
method tend to lean toward the cash method for cost savings and simplicity. Anyone who has
become at all familiar with the ease and inherent logic of accrual accounting will find this a
somewhat dubious reason for sticking with a cash method of accounting. Perhaps this nonprofit bias for cash method is due to a small organization not having a bookkeeper or only
having a treasurer that does not focus on the numbers more than once a quarter. Whether the
reasons for non-profits favoring cash method is based in fact or in fallacy, it is important to
consider what is best for the organization. And if you do choose to switch, keep in mind that
most organizational software’s allow for a seamless switch.
And while the decision whether or not to switch may focus on the bookkeeper or treasurer, it is
important to take the intended audience for your financial statements into consideration. For
example, foundations and government agencies that require audited financial statements
generally require financials in the accrual method since this is the only form accepted by GAAP.
It is always important to remember that board and management staff must understand the
method being used and need an accurate view of the organization for decision-making. Since
most non-profit boards contain at least some business people, it is not unusual for the board to
request the books be done on the accrual basis when otherwise very sophisticated financial
professionals cannot draw their own conclusion from your books without asking many questions
– questions which the Executive Director often cannot answer because of the complexity
brought in by “modified cash” systems!
1
Coley, Hillary. “Nonprofit-Specific Bookkeeping & Accounting.”
http://nonprofitaccountingbasics.org/nonprofit-specific-bookkeeping-accounting
2
Cherry, Bekaert & Holland, CPA’s. “The New Form 990: The Challenges and Lessons Learned So Far”
http://blogs.cbh.com/nfp/?p=237
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How Do Nonprofits Make the Change?
Using most nonprofit accounting software the switch can be rather simple, and painless. For
example, QuickBooks users have the option to perform reports on the accrual basis while
running on the cash basis to prepare tax returns. Click here for information on how to start
running nonprofit reports using the accrual method in QuickBooks3. This link above provides
basic steps to making this change.
Microsoft Dynamics (Great Plains) out of the box produces accrual method reports. For an
additional add-on Dynamics allows you to create cash method reports simultaneously with the
accrual method reports. Peachtree bookkeeping software is just as easy, click here for
instructions on how to switch from cash to accrual using that software4.
What Should a Nonprofit Organization Do?
More and more commentators are suggesting that nonprofits move to the accrual method, and
Cathedral Consulting encourages that sentiment. Cathedral suggests discussing this with the
organization’s management team, committees, board members, or decision makers on what
their preferred method would be for better understanding. The accrual method creates a
smooth flow of financials, helping everyone inside and outside of the organization understand
how the nonprofit is operating and performing. Depending on what bookkeeping software a
nonprofit organization uses, they need to look at the use of the cash method and the accrual
method to understand the difference on how each accounting method makes the organization
look.
Additional Information and Resources:
1. Cash or Accrual? Selecting the Correct Method:
http://www.allbusiness.com/accounting/241376-1.html
2. Does Full Accrual Accounting Enhance Accountability:
http://www.innocation.cc/scholarly-style/beechy4final1draft.pdf
3. Nonprofit Specific Bookkeeping & Accounting:
http://nonprofitaccountingbasics.org/nonprofit-specific-bookkeeping-accounting
Peter Giersch is COO and Managing Director and Michael Leppellere is a former Associate at
Cathedral Consulting Group LLC in the Midwest office.
For more information, please visit Cathedral Consulting Group LLC online at
www.cathedralconsulting.com or contact us at info@cathedralconsulting.com.
3
Ivens, Kathy. “Running QuickBooks in Nonprofits”
http://books.google.com/books?id=4aoBV5mDP1QC&lpg=PA210&ots=OEHSUZ_mTe&dq=quickbooks%20non%20profit%2
0cash%20to%20accrual&pg=PA213#v=onepage&q&f=false
4
eHow, Ian. “How to Use Peachtree Software.”
http://www.ehow.com/how_4969338_use-peachtree-software.html
Cathedral Consulting Group, LLC
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